At the most recent NASD Spring Securities Conference held in Chicago, Illinois, NASD enforcement personnel discussed their "short list" of hot regulatory enforcement issues that they believe will be focused on in 2005. While the list of hot topics was not all inclusive, there was a direct correlation between the hot topics, and recent enforcement actions. As a side note, it was also observed that in almost all enforcement actions, there was also a secondary claim that the respective firm failed to have adequate policies and procedures related to the basic area that the firm received its sanction. With the above in mind, the following sets for a number of the "Hot Enforcement Issues" for 2005

Proceeds Sales.

The NASD is re-focusing on the NASD Proceed Sale Rule, which generally governs the compensation generated when a customer sells securities through a broker/dealer and then uses the proceeds of that sale to pay for other securities purchased at or about the same time. To this end, on April 14, 2005, the NASD announced that Ladenburg Thalmann & Co. of New York, NY agreed to refund $1.2 million, plus interest, to customers who were overcharged compensation (both on the buy and sell side of the transaction) in "proceeds transactions. Additionally, the NASD also fined Ladenburg $275,000 and required the firm to retain an independent consultant to make recommendations for ensuring compliance with NASD's Proceeds Rule.

Mutual Funds

The NASD is still focused on B-Shares and breakpoints, but they are also looking at NAV Transfers.

B-Shares. On March 23, 2005, the NASD announced that it had censured and fined Citigroup Global Markets, Inc., American Express Financial Advisors and Chase Investment Services a total of $21.25 million for suitability and supervisory violations relating to mutual fund sales practices between January 2002 and July 2003. The cases against Citigroup and Chase involve their recommendations and sales of Class B and Class C shares of mutual funds, while the action involving American Express relates only to Class B shares. In all three cases, the firms made recommendations and sales of mutual funds to their customers without considering or adequately disclosing, on a consistent basis, that an equal investment in Class A shares would generally have been more economically advantageous for their customers by providing a higher overall rate of return. The firms were also sanctioned for having inadequate supervisory and compliance policies and procedures relating to these mutual fund sales.

In resolving these actions, the firms agreed to a remediation plan that includes over 50,000 households and more than 275,000 transactions in Class B shares, and to a lesser extent, Class C shares.

Market timing. On December 21, 2004, the NASD announced that it had censured and fined H&R Block Financial Advisors, Inc., $500,000 for enabling a hedge fund customer in its Orlando, FL branch office to engage in deceptive practices to market time mutual funds. NASD also ordered H&R Block to pay $325,000 to reimburse the affected funds.

On January 12, 2005 the NASD announced that it had censured and fined Banc One Securities Corporation $400,000 for failing to implement adequate supervisory systems and written procedures designed to detect and prevent "late trading" of mutual funds, and for inaccurately recording the entry time for customer orders.

Variable Annuities

Trade practices related to sale of variable annuities is very high on the radar, especially in the Southeastern Region of the NASD. Included in the issues raised were general suitability concerns, equity index annuities, and increasing concerns related to compensation issues and the suitability of riders.

To this end, on April 29, 2005, the NASD issued a news release regarding a settlement with Waddell & Reed, Inc. where the firm agreed to pay a $5 million dollar fine and up to $11 million dollars in restitution to settle NASD charges relating to variable annuity switching. Ultimately, the NASD charged Waddell & Reed with violating its obligations under NASD's suitability rule by failing to take reasonable steps to ensure that recommended variable annuity exchanges were in the best interests of customers.

Additionally, in the first case ever brought against a broker dealer for facilitating deceptive market timing in variable annuities, NASD fined Davenport & Co. LLC of Richmond, VA $450,000, and ordered the company to pay more than $288,000 in restitution to the affected funds. The fine also includes Davenport's failure to establish and maintain a reasonable supervisory system and written supervisory procedures designed to prevent late trading of mutual funds.

Fee Based Accounts

On April 27, 2005, the NASD issued a news release regarding the NASAD settlement, censure and fine of Raymond James & Associates, Inc. and Raymond James Financial Services, Inc. $750,000 for violations relating to the firms' fee based brokerage business. The NASD found that, from April 2001 through December 2004, the Raymond James firms failed to establish and maintain a supervisory system, including written procedures, reasonably designed to review and monitor their fee based brokerage business. In addition, the firms also violated NASD rules by recommending and opening fee based brokerage accounts for customers without first determining whether these accounts were appropriate and by allowing those accounts to remain open.

While only one case was brought this year, the NASD assumes that there will be additional cases in the near future.

Conflict of Interest and Revenue Sharing.

Revenue sharing has been an area of growing concern by the NASD, and a number of cases have been brought based upon a lack of disclosure related to revenue sharing relationships. On February 16, 2005, the NASD announced that it had charged American Funds Distributors, Inc. (AFD) with violating NASD's Anti Reciprocal Rule by directing approximately $100 million in brokerage commissions over a three year period to about 50 brokerage firms that were the top sellers of American Funds. The payments were made to reward the firms for past sales and to encourage future sales of American Funds' 29 mutual funds. AFD is the principal underwriter and distributor of American Funds, the third largest mutual fund family in the U.S. with more than $450 billion in assets and approximately 25 million shareholder accounts. The commissions were payments for executing trades for the American Funds' portfolio that were directed to the brokerage firms as additional compensation for past sales of American Funds, and to ensure that American Funds would continue to receive preferential treatment at those firms.

NASD's "Anti Reciprocal Rule," which first became effective in July 1973, is designed to prevent quid pro quo arrangements in which brokerage commissions, which are assets of the shareholders of the mutual funds, are used to compensate brokerage firms for selling the funds' shares. The rule also is designed to ensure that the execution of portfolio transactions by brokerage firms is guided by the principle of "best execution" and not by other considerations. In addition, the rule is meant to eliminate the danger that a brokerage firm, when recommending mutual funds to customers, will base its recommendations on the additional rewards the firm may receive in portfolio commissions from the funds rather than on the investment needs of the customer.

Additionally, on February 22, 2005, the NASD announced that it had fined Quick & Reilly, Inc. (now part of Banc of America Investment Services, Inc.) $570,000 and Piper Jaffray & Co. $275,000 for directed brokerage violations. Essentially, the NASD found that both firms operated "preferred partner" or "shelf space" programs, giving favorable treatment to funds offered by certain mutual fund companies in return for brokerage commissions and other payments. That special treatment included higher visibility on the firms' internal websites, increased access to the firms' sales forces, participation in "top producer" or training meetings, and promotion of their funds on a broader basis than was available for other funds. That conduct violated NASD's "Anti-Reciprocal Rule" which prohibits firms from favoring the sale of shares of particular mutual funds on the basis of brokerage commissions.

Research Analyst Rules.

The NASD is examining firms for compliance with the new rules as a part of the NASD examination program. To that end, on February 23, 2005, the NASD announced that it had fined and suspended former Jesup & Lamont Securities Corporation research analyst Gary Davis for trading contrary to the recommendations in his research reports and for other violations relating to his activities as a research analyst. Davis was suspended from the industry for six months, fined $130,000 and prohibited from acting as a research analyst for 18 months. Nearly $117,000 of his fine represents profits Davis made through his unlawful trading. NASD also charged Jesup & Lamont, a New York City broker dealer, and its chief compliance officer, Robert Strong, with failing to adequately supervise Davis.

Regulatory and Responses.

The NASD is looking at taking action against firms for not paying enough attention to the self assessments and requests for responses and information. To the extent the NASD believes that the information is not full and or complete, they intend to take action against the respective firms for a lack of co-operation. To this end, on November 22, 2004, the NASD announced that NASD's National Adjudicatory Council (NAC) permanently barred Frank Quattrone from working in the securities industry in any capacity for refusing to testify in an NASD investigation concerning his role in possible document destruction, obstruction of justice and other matters while at Credit Suisse First Boston (CSFB). The NAC overruled an earlier NASD hearing panel decision to fine Frank Quattrone $30,000 and suspend him for one year. In ordering the permanent bar, the NAC called Quattrone's conduct "egregious" and said it "impeded an NASD investigation and undermined the NASD's ability to carry out its regulatory mandate."

Market Regulation Areas of Focus for 2005.

With respect to Market Regulation, trading practices involving TRACE Securities and Municipal Securities are clearly targeted, including the completeness and accuracy of trade reports for TRACE Securities and Municipal Securities. In this area, the NASD will continue to look closely at the quality of data submitted by the firm to the NASD for TRACE, OAT and ACT reporting and routing information. Ultimately, even though a firm may have automated systems and or a third party provider, it is critical to back test the information to make sure it is accurate.

They are also looking at compliance and supervision with respect to Regulation SHO, the accuracy and timeliness of information published pursuant to SEC Rules 1 lAcl 5 (order execution) and 11 Acl 6 (order routing). Finally, the NASD is also focused on auto execution type short term manipulations in all forms, and quality assurance in automated systems for trading, trade reporting, regulatory reporting (OATS, Short Interest Reporting, 1 lAcl 5 and 1 lAcl 6), and other areas.

General Issues.

AML: Investigations currently range from procedures issues, to the actual filing of SAR's (i.e. a number of firms are not filing SARs when they possibly should be).

Gifts and Gratuities: This issue has moved back up on the screen, as it is generally associated with non-cash compensation issues. The NASD is looking at firms procedures very closely to determine that the firm is doing what it represents in the procedures.

529 Plans: The NASD is currently looking at situations where the firm offers only one specific state plan, with out disclosing that practice.

MSRB Filings: The NASD is getting active on MSRB trade reporting and MSRB Rules G-37 & 38 as it relates to the pay to play rules with consultants.